Surprise! HP discovers new internal disaster, takes $8.8B charge

Claims that subsidiary Autonomy has been cooking its books.

Hewlett-Packard's financial results for 2012 are not exactly a cause for thanksgiving.

Yathin S Krishnappa

Poor Meg Whitman can't catch a break. Remember that analyst briefing Hewlett-Packard held in October, where Whitman tried to air all of the company's bad news at once? Well, it looks like she missed some. And there's no telling where it stops.

Yesterday, HP announced that an internal investigation had found "accounting improprieties, misrepresentations and disclosure failures" in the financial records of Autonomy, the unstructured "big data" analysis software firm acquired by HP last year, after being tipped off by "a senior member of Autonomy's leadership team." The disclosure came as HP took a non-cash accounting charge of $8.8 billion—over $5 billion of it related directly to Autonomy's alleged book-cooking.

In other words, HP is saying that Autonomy, which it bought in August of 2011 for about $10.2 billion, is worth less than half that. And HP's executives are pinning the blame on Autonomy's founder and former CEO Mike Lynch (who was fired in May because of Autonomy's plummeting revenue), other members of Autonomy's management, and the accounting firm Deloitte—which performed the audit of Autonomy's books before the merger.

Booking hardware sales as software license sales to inflate the apparent size of the software business—accounting for about 15 percent of the company's claimed software revenue

Including license transactions to resellers as revenue before product was sold to end-users

Booking long-term software-as-a-service deals, where Autonomy hosted software for customers, as all-at-once revenue, before money was in hand

HP has gone to the authorities with the charges, contacting the UK's Serious Fraud Office and the US Securities and Exchange Commission. With the lawsuits that are sure to follow, it appears that HP's lawyers, still busy with the company's lawsuit against Oracle, are assured of continued job security. Job security for rank-and-file Autonomy employees doesn't appear to be threatened at the moment, either. "We remain 100 percent committed to Autonomy and its industry-leading technology," HP's announcement proclaimed.

The ghost of turkeys past

The remaining $3 billion or so of HP's accounting writedown, the company said, is "linked to the recent trading value of HP stock and headwinds against anticipated synergies and marketplace performance"—in other words, because of the rest of the company's bad news this quarter, including the indirect effect of the Autonomy mess.

Much of the blame for this can be convincingly pinned on the strategic direction HP took under former CEO Leo Apotheker. HP bought Autonomy as part of its effort to become more like IBM, moving away from the PC business and toward a more software and consulting-driven business model (a business that Apotheker, who had come from enterprise software vendor SAP, knew well).

The $8.8 billion writedown came as the company released its fourth-quarter and annual financial numbers, and it accounts for much of the company's $12.7 billion loss for the year. But even before taking the charge, the company's revenues were down $2 billion in the fourth quarter relative to the fourth quarter of 2011, and they were down $6.8 billion for the year—losses Whitman had earlier attributed to the company's structural and strategic problems brought on by previous management (a not-so subtle passing of blame to Apotheker).

On the bright side, HP's cash flow for the year moved in a positive direction to $4.1 billion—up 69 percent from 2011. So it's possible that the company will emerge from this latest rough spot in better shape—as long as no more skeletons hide in the company's fiscal closets.

HP is finally realizing that they paid way too much for Autonomy, and now they're blaming the accountants. Everyone blames the accountants.

Meg needs to take some responsibility for this; she was on the board that approved the Autonomy purchase, which was widely seen as terrible at the time.

I disagree, the large accounting firms over the last 15 years have taken the position of simply feeding back the answer you want rather than doing what they have been paid to do, take the creators of dragon dictate lawsuit against goldman sachs.

Companies need to be held responsible for their actions, and not simply let go because that is business.

You can bet that the major executives of both HP and Autonomy did quite well under the deal. And I'm betting the accounting firm profited as well. It's becoming more and more apparent that audits are basically worthless.

Don't agree about blaming the Board, and find the suggestion that they are just looking for a scapegoat in the accountants implausible.

The allegations made are ones you would not expect a Board to be able to check. If you are on a Board, approving or not approving a company purchase, you expect to be given the results of a proper purchase audit which will ensure that the numbers you are considering are clean. If you've demanded and paid for an external accounting firm to go over the books for you, then you should be doubly confident the numbers are clean. One of the things you are obviously paying for is an audit of revenue recognition policies.

If these allegations are true, then there are only a couple of ways the situation could have arisen. One is the external accountants were deliberately and systematically lied to. It could happen, it would be unusual and completely idiotic, but it could happen. Its more plausible than the second possibility, that the accountants simply did not check to make sure what the accounting policies in force actually were.

You would have to see what the Board saw. It could also be that the reports they received contained cautions on the accounting treatment and recognition of revenues, but that they did not understand or ignored them. That seems pretty unlikely too, because in that case they would surely not be suing. In fact, if they had been told that the revenue numbers depended on that sort of thing, they'd surely have run a mile.

We shall have to see. Either way its a mess. No company in good shape engages in the sort of accounting practices that have been alleged. Its going to be worse than described, if its really true, in terms of the future of the business.

The wreck of HP, started under Carly, continues apace. How to drive a once great company onto the rocks.

I love me some capitalism, but when some idiot CEO makes a terrible decision like this, loses a ton of cash, fires 15,000 employees to balance the books, then gets fired but still received $gazillion in severance, I have a hard time rationalizing it in my head.

HP is finally realizing that they paid way too much for Autonomy, and now they're blaming the accountants. Everyone blames the accountants.

Meg needs to take some responsibility for this; she was on the board that approved the Autonomy purchase, which was widely seen as terrible at the time.

I disagree, the large accounting firms over the last 15 years have taken the position of simply feeding back the answer you want rather than doing what they have been paid to do, take the creators of dragon dictate lawsuit against goldman sachs.

Companies need to be held responsible for their actions, and not simply let go because that is business.

Yes--and one would think after the undeniable conflict-of-interests in the Enron debacle (among others), that felled Arthur Anderson, there would have been more stringent regulation. There needs to be a separation of church and state, so to speak. If a financial services firm offers consulting, they can't be the auditor. The relationship is already clouded from the start.

Regardless of whether the HP board should have known they were paying too much or not, if the former Autonomy executives committed fraud (or ordered it committed) and Deloitte rubber stamped on the audit, then those players deserve to be in deep shit.

To widen this a bit, I wonder if the former management team at Autonomy received an auditor's blessing on the accounting tricks. If they came up with this on their own, that's one thing. If they pitched the idea to accounting and legal, and got an OK, then this will get even more interesting.

EDIT: if I'm reading the Forbes article correctly, Deloitte advised Autonomy on their accounting practices AND did the pre-purchase audit for HP. How HP would miss that potential for conflict of interest, I can't imagine.

HA! Man if I had any kind of management or leadership position at HP I would GTFO now. Its practically painting a target on itself that its bleeding money and dying and if you’re a shady character you could probably get in and exploit it while its burning to the ground.

EDIT: if I'm reading the Forbes article correctly, Deloitte advised Autonomy on their accounting practices AND did the pre-purchase audit for HP. How HP would miss that potential for conflict of interest, I can't imagine.

Deloitte and Autonomy, if colluding to fraud HP, may have omitted this information from HP. Or, HP knew about it and thought that because they were consulting Autonomy, they would have a better insight of the latter's financial perspectives.

But it is all conjecture. We'll only know what really took place after the criminal investigation takes place. All in all, I expect that someone ends being punished, not only HP's stockholders.

The purpose of an audit is to make sure GAAP are being followed; I understand that. Regretfully the GAAP are failing stockholders and boards because they no longer can be relied upon to certify that balance sheets are an accurate assessment of a company. The accounting profession, largely because of its search for more profit, has climbed into bed with corporate management in an ever increasing search for higher profits.

So who IS to blame in this kind of situation. No one wants to accept responsibility and therein lies the tragedy.

HP is finally realizing that they paid way too much for Autonomy, and now they're blaming the accountants. Everyone blames the accountants.

Meg needs to take some responsibility for this; she was on the board that approved the Autonomy purchase, which was widely seen as terrible at the time.

It sure looks to me like the CEO of Autonomy and the audit firm need to take the responsibility for this. Blaming the accountants for failing to identify fraud and blaming the CEO for fraud seems like a good idea when there is clear evidence of... fraud!

If anything, I'd say this is a promising sign; Meg is cleaning house and not pulling punches. If HP survives the process it should become profitable again.

Wickwick wrote:

Culturally Different wrote:

I hope no one else employ Leo Apotheker as CEO.

I hope no one else trust the board of directors that appointed Leo Apotheker.

Umm, I believe Meg Whitman (current CEO) was on that board, no?

Nope. Apotheker became CEO Nov 1 2010. Whitman joined the BoD January 2011.

Accountants generally don't just wake up one morning and go, "you know, I'd like to throw my whole career and certifications away by cooking the books" without direction from someone higher up.

All books could be considered "cooked". Accounting really isn't that straight forward and there are always numerous ways of tallying the numbers.

We need to know more before declaring if fraud was committed. A non-intuitive methodology might be legal and preferable for various reasons such as tax avoidance. As long as everyone understands the methodology, what first might appear as fraud might actually be well motivated and above board in terms of legality and profitability. Morality is another issue entirely.

In summary, it isn't obvious that anything wrong was done nor that it had to be directed by someone higher up. HP might be shifting the blame, having been cognizant of the accounting methodology the entire time. We just don't know. Either scenario is plausible and would come as no surprise.

Yes--and one would think after the undeniable conflict-of-interests in the Enron debacle (among others), that felled Arthur Anderson, there would have been more stringent regulation. There needs to be a separation of church and state, so to speak. If a financial services firm offers consulting, they can't be the auditor. The relationship is already clouded from the start.

Ostensibly this is what Sarbanes-Oxley does, and it's a result of things like Enron, and why the other big-four-and-a-half firms made structural changes to sever their consulting practices.

Of course, this is a little different, because Deloitte did Advisory (which is not _quite_ the same as consulting) for Autonomy and Audit for HP; they're not the same company. What HP really ought to have done is a one-time engagement with someone else (KPMG, PWC, whatever) since they'd have known this, but Deloitte really ought to have caught this kind of thing, either in Advisory (they'd be putting their name on the line to advise Autonomy do any of this) or Audit (they'd look like chumps, or criminals, or both).

I don't think HP can be faulted, or at least not much. I think Deloitte either goofed or deliberately misrepresented Autonomy's books, and they ought to take the hit.

HP is finally realizing that they paid way too much for Autonomy, and now they're blaming the accountants. Everyone blames the accountants.

Meg needs to take some responsibility for this; she was on the board that approved the Autonomy purchase, which was widely seen as terrible at the time.

Was Meg on the board that approved the purchase? Yes.Was it her predecessor that pushed the board for approval? Yes.Were the accountants and Autonomy in cahoots? Probably yes.

There is plenty of blame to go around since this wasn't exactly like picking up a small start-up for $50 mil and the technology being a flash in the pan. However as others have said, the board can only be blamed for not questioning the information enough, and for seeing their may be a conflict of interest in Deloitte's position(s) in the deal.

I do hope this move works out for them in the long run, but it is even more obvious that it will take a VERY long time (if ever) for HP to recoup the cost of this acquisition.

All of this sort of mess started when Congress changed the rules so that accounting firms were no longer liable for the audits they produced. The simple fix is to restore the liability of auditing firms for their audits. Then, and only then, will we see serious auditing taking place. Until then, it will be business as usual, where the auditing firms simply ask senior management what they want the books to read, and sign off on it.

HP is finally realizing that they paid way too much for Autonomy, and now they're blaming the accountants. Everyone blames the accountants.

Meg needs to take some responsibility for this; she was on the board that approved the Autonomy purchase, which was widely seen as terrible at the time.

I'm not sure exactly what "take some responsibility" means in real terms, but Whitman did say in an NPR interview that she regretted her vote to approve the acquisition. She was reasonably contrite and, I think, accurate in her finger-pointing at the accounting firm, Autonomy, and the HP board.

Including license transactions to resellers as revenue before product was sold to end-users

I'm slightly confused by this one. If [manufacturer] sells [product] to [wholesaler] and gets paid for it then that's revenue, whether or not [wholesaler] successfully sells it to [end user]. I'm not seeing why this should be any different for license transactions, i.e. if the company sold those licenses to the resellers and got paid then it's legitimate revenue, isn't it?

*) Including license transactions to resellers as revenue before product was sold to end-users *) Booking long-term software-as-a-service deals, where Autonomy hosted software for customers, as all-at-once revenue, before money was in hand

There's not enough information in the article to justify calling those two illegal. It sounds more like standard accrual-basis accounting to me.

Accountants generally don't just wake up one morning and go, "you know, I'd like to throw my whole career and certifications away by cooking the books" without direction from someone higher up.

All books could be considered "cooked". Accounting really isn't that straight forward and there are always numerous ways of tallying the numbers.

We need to know more before declaring if fraud was committed. A non-intuitive methodology might be legal and preferable for various reasons such as tax avoidance. As long as everyone understands the methodology, what first might appear as fraud might actually be well motivated and above board in terms of legality and profitability. Morality is another issue entirely.

In summary, it isn't obvious that anything wrong was done nor that it had to be directed by someone higher up. HP might be shifting the blame, having been cognizant of the accounting methodology the entire time. We just don't know. Either scenario is plausible and would come as no surprise.

From what I know for public companies there accounting standarts. This isn't accounting for internal purposes. I got little experience, but looking at these examples that seems to be wrong. It possible that old CEO and founders used creative accounting to make the company look better than it really was. Of course it will be really hard to get money back from past owners.

HP is finally realizing that they paid way too much for Autonomy, and now they're blaming the accountants. Everyone blames the accountants.

Meg needs to take some responsibility for this; she was on the board that approved the Autonomy purchase, which was widely seen as terrible at the time.

I disagree, the large accounting firms over the last 15 years have taken the position of simply feeding back the answer you want rather than doing what they have been paid to do, take the creators of dragon dictate lawsuit against goldman sachs.

Companies need to be held responsible for their actions, and not simply let go because that is business.

I largely agree. I have been an auditor at various Fortune 500 and 100 class companies for the last decade (IT, but I'm close enough to Finance to know the ugly details), and have worked very, very closely with auditors from the Big Four

But my experience has shown me that more than telling companies what they WANT to hear? The Big Four largely focus on protecting themselves by spending endless hours shuffling paper around, ensuring that the tiny details are correct while not WANTING to see the big picture.

Part of the problem is the nature of the Big Four. Every major company in the US is pretty much required (by market forces) to use one of them. Use a regional, and you get questions about why you can't stand up to "Big Four Scrutiny", even though that scrutiny largely consists of thousands of hours of nearly meaningless detail work.

While it is unspoken, the Big Four have (de facto) divided up all the important fish. Any of the firms is very similar to any other, in terms of audit process and procedure. All of them couch everything they say in non-committal "audit speak". And they know that if you jump ship to another big audit firm? THAT firm will be happy to charge you even MORE than they do, because of all the extra hours "getting to understand the environment".

It's a nice scam. And it has led, IMO, to a proliferation of nearly meaningless audit work prettied up to look like all those hours testing the "management reviews of the signoffs for additions to the new hire tracking system" really have ANYTHING to do with risk.

After all, communicating the big picture (and the REAL risk) brings with it risk to the audit firm itself. But communicating that "Yes, based on our test of 100 samples randomly chosen from inventory tracking documents during the period January 1 through June 30, items noted in the inventory tracking documents appear to have been properly signed for by a member of management with appropriate authorization.". carries little risk..because when things collapse? The Big Four have a copious paper trail showing that, technically, what they told the customer was true. By the way? Every hour they spend on trivial details? That'll set you back $225.

Best hardware engineers, anywhere. Proliants are so awesome I want to hug them.

Bad software developers and even worse business leaders.

Seriously. Their server support software is just awful, and their business decisions appear to be one blunder after another after another.

Get a clue already and fire your entire dev team and hire competent developers. Then get yourself some competent managers. The former may happen. The latter? Well the board isn't going to fire itself. Once-mighty HP may just drive itself over a cliff.

Sean Gallagher / Sean is Ars Technica's IT Editor. A former Navy officer, systems administrator, and network systems integrator with 20 years of IT journalism experience, he lives and works in Baltimore, Maryland.